Another Day, Another Gap

A strong start to the month of August in the SPX as buyers seek to dispel the 'sell in May go away' myth. The strong action today began with another >1% opening gap in the SPY ETF, the second such gap since only 2 sessions ago, probably as more bears are forced to cover. I suppose at least the adage never sell short a dull market is proven true. Such large gaps happening so close in proximity is in fact a fairly rare occurrence. In fact, from my SPY data going back to 2/1993, I can only find 8 instances of the SPY having 2 opening gaps of > 1% within a span of 3 sessions (two of them were rounded up to 1% but whats 0.05% between friends..). So, is this a sign of further strength? or have all the shorts already been forced to cover at the top and its down we go?

One would be quite right to read this as at least a sign of short term exhaustion in buying. Indeed out of the 8 instances, only once did the SPY managed to make a new high on the day after the second gap up day (tomorrow), suggestive of at least a pause and consolidation for the coming sessions. Thereafter, things look up for the bullish case again. The probability of the SPY making a new high, after the second gap up day, in the 5 sessions following are:

Day	Prob of new high
T+1 (Tomorrow)	1/8
T+2	3/8
T+3	3/8
T+4	5/8
T+5	7/8

On T+5, the average new high above the current high, is 1.03%. ($101.56 using today's high of $100.53) Not monstrous profits, but the odds seem pretty good. It also seems we can enter the long trade at better levels during the first 3 days, as from the 7 successful instances, the average pullback from the highs before the next upswing began is 2.6% (the min pullback was 1.9%, max 3.6%). The day on which the low print occurs on during the next 3 days is evenly split.

On the last note, its not all despair for the bears though, because for the one case where this did not work out, the SPY rolled over and dropped 5% after a week.